This study will examine (1) whether the passage of PPS caused hospitals to open skilled nursing units (SNU) and (2) whether ownership of such a unit affects hospital length of stay and choice of discharge disposition. Selected data from California hospitals for the period dating from 1982 to 1992 will be used for the study. First, a censored-regression model will be used to model the SNU decision. The regressor of interest will be a dummy variable indicating whether PPS is in effect. Because of the absence of an appropriate control group, the PPS effect is identified using an instrument such as the number of Medicare-aged persons living in the hospital's catchment area or per capita income among Medicare-aged persons. The effect of a SNU on average length of stay and choice of discharge disposition will be tested using a duration model that allows for multiple destinations, the competing risks model. Again, instrumental variables estimation will be used because the decision to own a SNU is endogenous. The same instruments will be used for the second estimation. This study will enhance understanding of the impactof changes in financial incentives imposed by a large government payer on the industrial organization of a health services market composed of nimble organizations prepared to respond quickly to environmentalchanges. More specifically, it should help policymakers understand the effects of fundling some parts of patient care while leaving other, related parts untouched. Health care providers may be faced with incentives that conflict with the original intent of the change, leading to unintended consequences.